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3 Reasons Why a 401(k) May Not Be Your Best Retirement Savings Choice

By Maurie Backman – Oct 7, 2020 at 7:18AM

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Building a retirement nest egg? Don't assume that a 401(k) is your best bet.

Social Security generally won't pay you enough money to retire comfortably. To achieve that goal, you'll need personal savings to supplement those benefits.

You may decide that a 401(k) plan is the best place to house your savings. With a 401(k), contributions are easy. You simply sign up for your employer's plan, indicate how much money you want to be deducted from each paycheck, and watch as your plan is funded automatically.

401(k) plans may be convenient, but they also have their pitfalls. Here are a few reasons why a 401(k) may not be the right choice for your nest egg.

1. Limited investment choices

When you save for retirement in an IRA, you can choose from different funds or individual stocks, but the latter is off the table with 401(k) plans. In fact, your employer's plan might only give you access to about a dozen different funds, and that narrow selection window means you may not find choices that align with your investment goals and risk tolerance. Also, buying individual stocks could mean scoring greater returns than what your 401(k) funds permit.

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2. High fees

There are costs associated with administering a 401(k), and make no mistake about it: They're probably being passed along to you. Furthermore, the investments you select for your 401(k) will come with their own fees, known as expense ratios. The limited choice of funds we just talked about could really hurt you on these ratios. If you're forced to stick mostly to actively managed mutual funds, your investment fees could be quite high. IRAs, on the other hand, tend to offer more affordable investment choices.

3. No Roth option

Though many 401(k) plans do have a Roth savings option, not every plan comes with one. And that could put you at a major disadvantage during retirement. The upside of saving for your senior years in a Roth account is that your withdrawals during retirement will be yours to enjoy free of taxes. That will not only make it easier to manage your money, but also perhaps create a scenario in which you don't need to pay taxes on your Social Security benefits.

If Social Security is your sole income source as a senior, you'll generally avoid taxes at the federal level, but if you have outside income, your risk of being taxed on your benefits increases. Since Roth distributions don't count as taxable income, they won't hurt you in this regard. If your 401(k) doesn't come with that option, though, you won't get to benefit from it.

Save carefully for retirement

Your 401(k) might offer low fees, plenty of investment choices, a Roth savings option, and a generous employer match to boot. But if it doesn't come with these features, then it may not be the best choice for your retirement savings. If that's the case, it pays to consider putting your savings into an IRA, or splitting your savings between an IRA and a 401(k). Generally speaking, it's worth putting money into a 401(k) for your employer match alone, but if your plan isn't great, a 401(k)/IRA split could be a much better solution for you.

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